Managing the refund well is the linchpin in the RRSP vs. TFSA debate

There is no shortage of blogposts and media articles about which account is better for retirement purposes: the Registered Retirement Savings Plan (RRSP) or the Tax Free Savings Account (TFSA). I’ve got my preference for which account I focus on for retirement purposes but let’s recap some key points about each plan first:

RRSP

TFSA

A tax-deferral plan.

A tax-free plan.

Contributions can be made with “before-tax” dollars as part of an employer-sponsored plan or “after-tax” dollars when a contribution is made with a financial institution.

Contributions are made with “after-tax” dollars.

Contributions are tax deductible; you will get a refund roughly equal to the amount of multiplying your contribution by your tax rate.

Contributions are not tax deductible; there is no refund to be had.

If you don’t contribute your maximum allowable amount in any given year you can carry forward contribution room, up to your limit.

If you make a withdrawal, contribution room is lost.

If you make a withdrawal, amounts withdrawn create an equal amount of contribution room you can re-contribute the following year.

Because contributions weren’t taxed when they were made (you got a refund), contributions and investment earnings inside the plan are taxable upon withdrawal. They are treated as income and taxed at your current tax rate.

Because contributions were taxed (there was no refund), contributions and investing earnings inside the account are tax exempt upon withdrawal.

Since withdrawals are treated as income, withdrawals could reduce retirement government benefits.

Withdrawals are not considered taxable income. So, government income-tested benefits and tax credits such as the GST Credit, Old Age Security (OAS) and the Guaranteed Income Supplement (GIS) aren’t affected by withdrawals.

You can’t contribute to an RRSP after age of 71. Accounts must be collapsed in the 71st year.

You can contribute to a TFSA after age of 71.

The Summary: part of your RRSP is borrowed money.

The Summary: all of your TFSA is your money.

Based on my personal investment plan, I feel the TFSA ultimately trumps the RRSP as a retirement vehicle even though I contribute to both every year. All the money in the TFSA is mine to keep, grow and manage with no tax consequences. The RRSP refund is great but it’s actually temporary; you need to give it back at some point. This makes reinvesting the RRSP refund year after year absolutely critical in my opinion to optimize wealth building – to take major advantage of an essentially long-term but not permanent government loan.

That said about this loan I firmly believe using the RRSP will work out very well for the majority of Canadians, hopefully myself included! Contributing to the RRSP makes the most sense when your marginal tax rate at the time of contribution is greater than your marginal tax rate at the time of withdrawal. If this tax situation applies to you this RRSP season then by all means use the RRSP as much as you can to defer tax now, grow your portfolio and get your refund back to reinvest money back into your RRSP. If however for whatever reason, you need to use the RRSP refund for other things this spring (like a vacation?) that’s fine. As part of this tax season just be mindful of the potential consequences of not managing the refund well this and every “RRSP season”.

Are you contributing to your RRSP this year? If so, what is your strategy to manage the refund?

11 Responses to "Managing the refund well is the linchpin in the RRSP vs. TFSA debate"

I’m enrolled in omers, so i put most of my money into a TFSA instead of RRSP’s. i still put $100 a month into RRSP’s but i spend the refund instead of reinvesting. if i leave my omers employee, then i would change my strategy

First $5500 into TFSA, any funds above this that you can set aside place in too RRSP.
This will be the best option for the vast majority of people. If you can’t leave your savings alone, then skip the TFSA and enjoy the lock in power of an RRSP.

We contributed the max to our RRSPs before we met, married, bought a home, and had kids. Now the mortgage is paid off and the TFSAs are maxed, we are quickly maxing out our RRSPs. For us it worked well. If TFSAs had been available back then when the dinosaurs roamed, we would have probably maxed TFSAs first, then RRSPs if we had enough. At $5000ish/year a TFSA isn’t really enough retirement savings unless you have a very low income or a very high work pension.

If they make a voluntary CPP plan available, we would max TFSA, max voluntary CPP, then max RRSP.

Maxing our your RRSPs is an excellent thing to do. My position is, if this account is used wisely, it’s phenomenal. I suspect many people don’t use this account wisely, which is why the TFSA is a consideration for them.

Congrats on having your mortgage paid off. We’re 9 years away from that…